Savova: Trust should not be compromised by chasing investments that may benefit institutions more than the individuals they serve
The debate over whether pension funds should allocate more towards illiquid assets, such as private equity and infrastructure, has intensified, with policymakers pushing for a shift in investment strategy.
While the ambition to boost economic growth and provide long-term funding for vital infrastructure projects is laudable, the implications for pension savers are troubling. Prioritising investments in illiquid assets risks leaving savers with poorer retirement outcomes due to higher fees, diminished transparency, and limited flexibility.
Private market assets, by their very nature, are opaque and complex. Unlike publicly traded securities, which are priced openly and traded in liquid markets, private equity, infrastructure and other illiquid investments often lack clarity.
The valuation of these assets relies on appraisals that may be internal and subjective, leaving room for misrepresentation. Concerns about false valuations have been rife for years and the Financial Conduct Authority is currently understood to be investigating the matter through a multi-firm review. Financial services are about trust: opaque asset valuations have a habit of going wrong. The 2008 crisis and 2022 LDI blow-up come to mind.
The cost structure of illiquid investments is another significant concern. Research by French economist, Ludovic Phalippou, highlights that private equity funds, for example, have delivered returns comparable to broad stock market indices but at a much higher cost. Phalippou estimates that these costs can erode up to seven percentage points of gross returns when management and performance fees are accounted for, and this doesn't include additional monitoring and transaction fees.
The mismatch between the liquidity needs of pension funds and the nature of illiquid assets compounds the risks. Pension funds rely on a steady cash flow to meet their obligations to retirees. However, assets like real estate and private equity cannot be easily or quickly converted to cash without incurring significant losses, and sometimes not at all. This liquidity mismatch could create severe financial strain during economic downturns or periods of high payout demand, forcing funds to sell assets at unfavourable prices. Such situations jeopardise the financial security of those who depend on their pensions for a stable retirement.
Moreover, the long-term horizons associated with illiquid investments reduce the flexibility of pension funds to adapt to changing market conditions. These investments often span 10 to 15 years, locking funds into strategies that may no longer align with the economic environment or the needs of retirees.
For individuals approaching retirement, such rigidity can be particularly harmful, as it limits their ability to adjust to shifting financial circumstances. When pension funds are unable to capitalise on favourable market conditions or exit underperforming investments during downturns, savers bear the brunt of these inefficiencies.
With so much that could go wrong, we must ask what the push into the unknown can deliver in additional returns. The answer is: not much. The government cites the success of the Australian superfunds in delivering strong performance, but according to Corporate Adviser the median UK pension fund has performed marginally better than Australian peers over the past five years without introducing the risk of illiquid assets. It seems only the fund managers set to reap higher fees will be certain winners if the government has its way.
Pension funds are entrusted with the responsibility of safeguarding the financial futures of millions of savers. This trust should not be compromised by chasing investments that may benefit institutions more than the individuals they serve. Nor should this trust be undermined by a government that dictates or mandates investment policy.
As policymakers and industry leaders consider the future of pension investments, they must ensure that savers' needs remain at the forefront of decision-making. Anything less risks undermining the very purpose of the pension system: to provide a secure and happy retirement for all.
Romi Savova is founder and chief executive of PensionBee
